Question 3

Paisley Brothers plc, a company producing loud paisley shirts, has net operating income of 2000 and is faced with three options of how to structure its debt and equity:

1. To issue no debt and pay shareholders a return of 9%;
2. To borrow 5000 at 3% and pay shareholders an increased return of 10%
3. To borrow 9000 at 6% and pay a 13% return to shareholders.

Required:

Assuming no taxation and a 100% payout ratio, determine which financing option maximises the market value of the company. (20 Marks)